Nasdaq Will Keep On Winning In The 2020s by Ian Bezek

Summary

Nasdaq, like many stock exchanges, is making new highs as the year concludes.
Despite that, the stock is still reasonably priced.
Nasdaq can handle technological change.
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As you may know, I'm a fan of stock exchanges. Businesses with high profit margins, strong network effects, and low marginal costs for additional revenue growth tend to deliver market-beating results over time. Generally, people look for these in a few select industries such as software. But there's plenty of other things out there such as airports and stock exchanges that enjoy similarly strong economics.

I've been a proponent of CBOE (CBOE) stock throughout 2019. However, it's far from the only listed stock exchange, and I've also taken a position in Nasdaq (NDAQ). Here's why I'm still bullish on Nasdaq, even as the stock has just reached new highs:

Data by YCharts

More Than Just A Rising Trading Volume Play

If you haven't looked at a 10-K or annual report for a stock exchange company recently, you might be under the impression that they are essentially a toll operator that takes a tiny chunk of transactions as their cut of the action. And that's not wrong. But the business has evolved beyond just that. As it stands, market services and technology make up half of revenues, with the other half coming from elsewhere:

Source: Nasdaq's 10-K

What else is going on here besides collecting fees from operating the Nasdaq exchange? Much of it is information services, which we'll discuss more in a minute. There's also a great deal of R&D and rolling out of new technology products for financial products around the world. See this from Nasdaq's most recent 10-K:

Powering over 100 market infrastructure operators in more than 50 countries, our Market Technology business is a leading global technology solutions provider and partner to exchanges, clearing organizations, central securities depositories, regulators, banks, brokers, buy-side firms and corporate businesses. Our solutions can handle a wide array of assets, including but not limited to cash equities, equity derivatives, currencies, various interest-bearing securities, commodities, energy products and digital currencies. Our solutions can also be used in the creation of new asset classes, and in 2018, Nasdaq partnered with non-capital markets customers, including those in insurance liabilities securitization and digital advertising futures trading.

Nasdaq shares the features you like to see at investment banks or futures operations; they are constantly involved in the creation of new products. Competitor CME Group (CME) recently announced, for example, that it is launching futures contracts on 20,000 pound blocks of cheddar cheese. I'm not joking.

Some of these take off in a massive way, like the CBOE's VIX index. Many disappear entirely - it's trial and error. The potential for any of these new sorts of products to become the next VIX offering that gains widespread adoption offers huge potential upside. With Nasdaq providing the technological plumbing for all sorts of new financial products, be it insurance securities, digital advertising futures, blockchain, or something we haven't yet thought of, there's a good chance Nasdaq will be collecting recurring revenues off them for many years to come.

The nice thing is you get significant upside to all sorts of new and emerging trends without the risk of wipeout failure. If you buy a blockchain stock, or an independent smallcap payments company, for example, there's a good chance your investment ends up going to zero if things don't go exactly according to plan. With something like Nasdaq's stock, you are only paying 20x forward earnings for a high-quality business anyway, so if all the big future growth possibilities fail to play out, it's hardly a deal-breaker.

Many investors are familiar with this optionality as it applies to huge business. Buy Alphabet (GOOGL) for the money-printing search business and if the moonshots hit, you get even more upside as a bonus. Or buy Facebook (FB) for the existing ads business and if they figure out how to monetize WhatsApp, you get a home run.

...Originally Posted On Seeking Alpha

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